An average strike call is similar to a standard call option, except that it uses the...
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An average strike call is similar to a standard call option, except that it uses the average asset price over a predetermined averaging period as the strike price. Consider a 3-month average strike call on a non-dividend-paying stock with a current price $60. Assume the stock price evolves according to a three-period binomial tree. Then the time length of each period is At = 1/12. In each period, the stock price at the end of period either goes up to 1.1 or goes down to 1/1.1 of the price at the beginning of the period. The strike price of this option is the average stock price over the first three periods, i.e., (S(0) + S(At) + S(2At)). In other words, the option pays off max {S(3At) – }(S(0) + S(At) + S(2At)), 0} at the maturity date 3At. Suppose the interest rate is 5%. Try to use risk- neutral pricing to find the price of this average strike call. An average strike call is similar to a standard call option, except that it uses the average asset price over a predetermined averaging period as the strike price. Consider a 3-month average strike call on a non-dividend-paying stock with a current price $60. Assume the stock price evolves according to a three-period binomial tree. Then the time length of each period is At = 1/12. In each period, the stock price at the end of period either goes up to 1.1 or goes down to 1/1.1 of the price at the beginning of the period. The strike price of this option is the average stock price over the first three periods, i.e., (S(0) + S(At) + S(2At)). In other words, the option pays off max {S(3At) – }(S(0) + S(At) + S(2At)), 0} at the maturity date 3At. Suppose the interest rate is 5%. Try to use risk- neutral pricing to find the price of this average strike call.
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SOLUTION 1 The current stock price S0 60 2 The riskfree rate is 5 per period The time length of eac... View the full answer
Related Book For
Financial Reporting And Analysis
ISBN: 9781260247848
8th Edition
Authors: Lawrence Revsine, Daniel Collins, Bruce Johnson, Fred Mittelstaedt, Leonard Soffer
Posted Date:
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